Pinpointing Forex Trend Trade Entries with Stochastics

by
Gregory McLeod

- An uptrend is made up of higher highs and higher lows. Traders can use Stochastics to find excellent risk to reward entries at those low support points in the trend.

- A downtrend is made up of lower highs and lower lows. Forex traders can use Stochastics to find excellent risk to reward entries at these resistance high points

- Stochastics can be used to alert a forex trader to either tighten stops, reduce the position size, or take profit once in a trend trade.

By far, traders who trade in the direction of the predominant daily trend have a higher percentage of success than those who trade the counter trend. One of the biggest attractions of the Forex market it is characterized by long trends that afford traders the potential to make hundreds of pips if they have timed their entries with precision and used protective stops to limit risk.

The mantra, “the trend is your friend until it ends,” can be found in many trading books, but it seems that many forex traders have not made the trend their friend and in some cases, the trend has become the enemy. Rather than being on the receiving end of those pips afforded to traders who have correctly entered the trend, many traders have been on the “giving” end of the trade losing pips while fighting the trend.

As people have turned to online dating services to meet their ideal match, forex traders can turn to stochastics as a way of making the trend the their friend again.

Learn Forex: Stochastics Showing Entries in GBPUSD Uptrend

(Created using FXCM’s Marketscope 2.0 charts)

In an uptrend on a daily chart, stochastics %K and %D lines moving below the horizontal ‘20’ reference line and coming back above the 20 line indicates that the profit-taking correction is coming to an end. The stochastic crossing up also tells us that buyers are beginning to enter the market again. In addition, this shows that there is good support.

How to Trade the Trend Using Stochastics

Patience is the name of the game when attempting to trade with the trend. Getting into the trend too early can expose traders to large drawdowns. Getting in too late reduces the amount of profit before the swing is completed.

Use the stochastics indicator to find that “Goldilocks” entry of not too early and not too late. Once a strong uptrend is found, wait for stochastics with the settings of 15, 5, 5 to move into the oversold region below the 20 horizontal reference line. Next, wait for the %K and %D lines to move back above the 20 line. Enter long with a stop placed a few pips below the last low. Set a limit for at least twice the size of the stop.

Learn Forex: GBPUSD Risk to Reward Setup

Once in an uptrend position, traders will attempt to squeeze as much profit as possible. Traders usually take profits on their open position or trail stops once stochastics moves into the overbought region. It is important to note that a forex currency pair can continue to make new highs even though stochastics is in the overbought region.

So next time you see a trend and you do not know how to make it your “friend”, let the stochastics indicator introduce you! Once these swings are highlighted by stochastics, stop placement becomes easier as well. stochastics crossovers in an uptrend can help you pinpoint your entries to join the major trend.